Chapter 3: Internal Analysis: Strengths, Weaknesses, into valuable outputs, and put them in the hands of

and Competitive Advantage customers.

The value chain, or the steps in the process it takes to - Porter’s value chain not only provides a
transform raw inputs into finished outputs. framework to describe the activities a company
performs; it also can help to identify which
- It can help you understand the activities within
activities represent the firm’s competitive
your business that create value
strengths and weaknesses.
- Developed by Michael Porter, the value chain
is a way to depict and evaluate the activities a The value chain helps managers identify areas in which a
company performs firm has an absolute strength but provides no guidance
about strength relative to competitors
Value chain – visual description of the steps required to
turn raw materials into finished products and/or services. The RESOURCE-BASED VIEW
The value chain also describes key functions of the
Resources, capabilities, and priorities can be thought of
company linked to each stage and functions that span its
as answers to basic questions that firms face.
productive activities.
- Resources are what a firm employs to create
Steps to create a Value Chain:
value and competitive advantage.
1. Map out sub activities - Capabilities represent how firms do things—the
2. Analyze the sub activities processes they use.
3. Examine the linkages - Priorities explain why firms allocate critical
resources to achieve key objectives
Resources – all assets, brands, land, information,
knowledge, and so on, controlled by a firm that enable it
to conceive of and implement strategies that improve its
efficiency and effectiveness.
Capabilities – procedures, processes, and routines firms
employ in their activities.
Priorities – firm’s values and rankings of what is most
important.
Assets – tangible or intangible resources or factors of
production that create economic value for the firm when
employed.
RESOURCES
- provide the answer to the question, “What
creates the firm’s strengths?”
- “Resources include all assets, capabilities,
organizational processes, firm attributes,
information, knowledge, etc. controlled by a
firm that enables the firm to conceive of and
implement strategies that improve its efficiency
and effectiveness
- this definition clearly identifies what could be a
resource, but its breadth makes it difficult to
identify and limit what types of things count as a
resource. Resources are the “what” of
competitive advantage.
This figure captures the production process that a firm
uses to acquire and import raw materials, transform them
Accountants classify resources as tangible or intangible Processes or routines represent deeply engrained
assets. Tangible resources are those with physical habits of behavior that take years for companies
presence, such as land, factories, machinery, equipment, to perfect. As firms and their managers master
or cash. Intangible resources are economically valuable the ongoing process of learning and adjusting in
assets that “do not have physical presence,” and include the face of competitor, customer, or market
brands, licenses patents, knowledge, and reputation. changes, they develop a formidable set of
dynamic capabilities
4 categories of resources are important contributors
to competitive advantage: PRIORITIES
1. Physical resources, such as plant or equipment - resources and capabilities help firms create and
2. Financial resources, such as free cash flow deliver unique value. Priorities drives the
3. Human resources, including employee know- choices into which resources and capabilities a
how, management skill, and talents firm should invest money and time, which are a
4. Intangible resources, such as brands and patents firm’s rankings about what is most important.
- driven by a company’s underlying values, its
leaders’ beliefs about what is right and wrong,
good and bad, desirable and undesirable.

CAPABILITIES Values lead to priorities that help executives, managers,

and employees make decisions. Priorities drive the
- processes that the firm has developed to creation of resources and capabilities in two ways.
coordinate human activity in order to achieve
specific goals. 1. First, priorities guide resource allocation
- Capabilities represent the “how” of competitive processes such as capital investment, human
advantage capital acquisition and training, and brand
development.
Operating capabilities – procedures, processes, or 2. Second, priorities maintain those allocations
routines for delivering value to customers, employees, over time when things get tough.
suppliers, or investors.
Creating a Sustainable Competitive Advantage: The
Dynamic capabilities – procedures, processes, and VRIO Model of Sustainability
routines that continuously expand existing resources or
improve operating capabilities - Competitive advantages arise when resources or
capabilities possess two attributes: Value and
Competitive advantage relies on a strong set of operating rarity.
capabilities. A firm’s advantage becomes stronger if it - Two other principles determine the durability, or
develops dynamic capabilities, processes that are sustainability, of competitive advantage:
designed to continuously expand existing resources or to Inimitability, the characteristics that make a
improve or modify operating capabilities. resource or capability difficult to imitate, and an
Dynamic capabilities can help firms modify and evolve organization’s ability to exploit profit returns
processes to keep pace with environmental changes such generated by its unique and valuable resources.
as new competitors, shifting demographics, or emerging Together, these four characteristics—value,
technologies. They can also enable firms to incorporate rarity, inimitability, and organization to exploit
learning into their processes. profits—are often abbreviated as VRIO.

Companies with strong dynamic capabilities have a more Value – worth or utility.
secure foundation for competitive advantage than those Rarity – to be uncommon, or not available to other
without them, for two reasons: competitors.
1. First, dynamic capabilities entail complex Inimitability – attribute of a resource that describes the
connections and coordination among different degree of difficulty a competitor would face in copying,
internal units within the firm. imitating, or mimicking the value of that resource
2. Second, dynamic capabilities take time to
develop and require significant learning.
VALUE Tacit Knowledge
- denotes worth for customers. - such easy-to-codify-and-learn knowledge is
- products or services have value when they create referred to as explicit knowledge. Tacit
direct pleasure, satisfaction, or happiness for the knowledge is just the opposite.
end user, or when they create indirect - Many valuable skills and processes, such as Walt
opportunities for users to experience pleasure Disney’s knack for choosing good stories or
and satisfaction. Steve Jobs’s ability to spot great design in a
- the higher the value, the higher the price that product, can’t be learned easily, if they can be
buyers are willing to pay. learned at all. These skills are difficult, maybe
- low price itself may produce some direct even impossible, to learn, teach, or coach,
pleasure for users, but its benefits are mostly because they are based on tacit knowledge.
indirect, because purchasing products and - Tacit knowledge is sticky, or immobile, and
services at a low cost usually leave users with difficult to imitate by competitors.
more money to spend on other things that
Causal Ambiguity
provide them pleasure or satisfaction.
- resources that help a firm bring such - Causality refers to the notion that one thing
differentiated products and services to the causes another: A leads to B.
market create value for customers. - Sometimes, however, the causal relationship is
unclear or ambiguous, and the relationship
RARITY
between variable A and outcome B is difficult to
- to be rare is to be uncommon, or not available to disentangle. You might have learned in statistics
other competitors. Unique is often used as a courses that correlation does not equal causation,
synonym for rare and just because A and B appear together does
- Rare or unique resources create competitive not mean that A causes B.
advantage through a basic principle of
Complexity
economics—scarcity.
- When products or services are scarce, users are - Resources, capabilities, and priorities become
often willing to pay a higher price for them than difficult for competitors to imitate when they
they would if the same products or services were span the organization or contain many
more commonly available, leading to higher interrelated elements and exhibit substantial
company profit complexity
INIMITABILITY Time Compression Diseconomies
- is the extent to which competitors cannot easily - Diseconomies happen when an action increases,
reproduce a product by employing equal, or rather than decreases, cost and inefficiency.
equivalent, sources of value in their own - Timing is crucial in the development or
products and services. deployment of many resources, capabilities, or
priorities and can become a diseconomy in many
cases.
Path dependence means that the process through which
- resources that come from natural or physical
a resource or capability came into being may make it
processes, such as biological growth limits in
difficult for competitors to imitate.
biotechnology, pharmaceutical research, or
- helps to block imitation when resources or forestry, cannot be rushed.
capabilities follow a sequential development - Similarly, resources that come from differences
path—for example, when previous investments in individual or organizational abilities to learn
enable later ones, or when significant learning require adequate time for lessons to be
underlies the resource or capability. deciphered and processed
Network Effects and First-Mover Advantages and rare and enjoy a period of competitive
advantage.
- Much of the reason eBay is so successful has to
- Over time, however, competitors can imitate
do with network effects, which economists call
these resources and create competitive parity in
positive network externalities
the industry. Parity means that a company
- eBay wins because of its network effect. If you
survives but has no real competitive advantage
want to sell your old stuff, where do you want to
over rivals
sell? Some place where there are lots of potential
buyers. If you want to buy stuff, where would Competitive failure – when firms can’t create value for
you look? In a place with lots of sellers! More their stakeholders, they don’t survive.
sellers attract more buyers, who in turn attract
Competitive parity – when a company survives but has
more sellers. It’s a virtuous circle.
no real competitive advantage over rivals
Positive network externalities - when the value of a
To create competitive advantage in the long run—an
product increases with the number of users. virtuous
advantage that endures over several years—a firm must
circle When more sellers attract more buyers, who, in
create barriers to imitation. Barriers make it difficult for
turn, attract more sellers.
competitors to offer similar products or services, drive
Virtuous circle - when more sellers attract more buyers, prices down, and dissipate the firm’s superior profits
who, in turn, attract more sellers.
Sustained competitive advantage – when firms
Organized to Exploit combine the legal elements, intellectual property rights,
administrative elements, and cultural elements, allowing
- A firm may employ valuable, rare, and difficult-
them to capture high profits that come from their
to-imitate resources and yet still lack a sustain
valuable, rare, and inimitable resources, capabilities, or
able competitive advantage because the firm
priorities.
may not be organized to exploit or have the
contracts and systems in place to capture the Gathering Data for the Competitive Advantage
profits that resources create Pyramid Analysis
Organized to exploit – the degree to which the legal, Data to complete a pyramid come from a number of
administrative, and operating structure of the firm allows sources. You can use three main types of data:
it to capture the rents generated by resources.
1. Archival data: Written or numeric information
Assessing Competitive Advantage with VRIO can be found in the library or on the Internet.
2. Interviews: Interviews can range from personal
questions to impersonal surveys.
3. Observation: Your own experiences, such as
visits or use of products or services, are also
valuable.

- Figure 3.2 shows the relationships between

VRIO attributes of resources or capabilities and
competitive advantage.
- in the real world, firms that can’t create value for
their stakeholders don’t survive. - The competitive advantage pyramid provides a
- These businesses experience competitive failure. way for you to quickly document and understand
Many companies, especially new start-ups, a company’s sources of competitive advantage,
introduce valuable products that are also unique and it allows you to make some judgment about
 how durable and sustainable that advantage
might be

 Strategy tools can be used to better understand

how companies create and sustain competitive
advantages through their own efforts, as opposed
to merely relying on the industry’s structure.
 The value chain provides a broad and
comprehensive roadmap for identifying the
sources of a firm’s strengths and weaknesses
among its different value-creating functions and
infrastructure elements.
 The competitive advantage pyramid is a tool
to help identify, categorize, and assess the
overall strategic advantages of a firm. The
diamond allows depth of analysis and
understanding about the root causes of a firm’s
competitive advantages.
PESTEL Framework
- one important tool that executives can rely on to
organize factors within the general environment
and to identify how these factors influence
industries and the firms within them.
P – Political factors include elements such as tax
policies, changes in trade restrictions and tariffs, and the
stability of governments
E – Economic factors include elements such as interest
rates, inflation rates, gross domestic product,
unemployment rates, level of disposable income, and the
general growth or decline of the economy
S – Socio-cultural factors include trends in demographic
such as population size, age, and ethnic mix, as well as
cultural trends such as attitudes toward obesity and
consumer activism
T – Technological factors include, for example, changes
in the rate of new product development, increases in
automation, and advancements in service industry
delivery
E – Environmental factors, also called ecological factors,
include, for example, natural disasters, global warming,
pollution, and weather patterns
L – Legal factors include laws involving issues such as
employment, health and safety, discrimination, and
antitrust.